Friday, November 28, 2008

Introducing Premier Exhibitions

Remember the trips to the exhibition when you were young?(yay!). Remember the trips to the museum?(Honey, we have visitors. We ought to take them to the museum, it'd be so educational). Combine the two into one experience and you've got Premier Exhibition's business.

Premier's a kind of a hybrid pick. It's a part special situation, part (possibly) long-term hold. Let's look at the special situation part first. Premier's most significant asset is its fully owned subsidiary, RMS Titanic Inc. (http://www.titanic-online.com). The RMS Titanic Inc. is valuable because it is the only entity in the world that is allowed to look for and recover items from the sunk Titanic. See the FAQ on their website for more detail. They have recovered about 5500 artifacts from the Titanic so far which are extremely valuable. Just how valuable are they to Premier? You'll be sorry you asked. The answer to the question of how valuable the artifacts are depends on who has legal ownership of the items.

1. Of the 5500 artifacts, Premier has the title to 1800 artifacts, free and clear, awarded to it by a French court. This ownership is not in dispute and Premier estimates the fair value of these artifacts at $46 million.

2. Premier has "salvor-in-possession" status for the rest of the artifacts. What does this mean? This means that Premier essentially is the custodian of the artifacts until a decision is made regarding their ultimate destiny. Following a court order last October, Premier moved the courts for a "salvage award" last December. What's a salvage award, you ask? It's compensation for the act of salvaging property from a vessel in peril. 

There's two ways a salvor can be compensated:
a. In cash, based on the Blackwell factors (you can look these up, if you are interested. I now know more maritime salvage law terms than I ever wanted to know, which was nothing).
b. "In-specie" which means that the salvor gets ownership of the recovered property with an attached set of covenants that they must agree to abide by.  

Once Premier moved the courts for a salvage award, the US government joined the case as a "friend of the court". Outside of Premier, the US government is the most interested party in the Titanic wreck site. The US government believes that an "in-specie" award with the necessary covenants is one possible appropriate mechanism of compensating Premier (http://www.prxi.com/pdf/rmstorder.pdf, p4). As of September 15 of 2008, Premier had submitted revised covenants that it would adhere to if it were granted ownership of these artifacts via an "in-specie" award. There isn't a date set for the court's ruling on this matter, but it looks like Premier is virtually certain to be granted an "in-specie" award, subject to reaching an agreement wrt to the covenants with the US government.
 
Premier's estimate of the fair value of these artifacts: > $100 million. See Premier's investor presentation from earlier this year for fair value estimates of the artifacts they own and the artifacts that are currently being adjudicated on by the court: http://www.prxi.com/pdf/merriman.pdf (p7)

To summarize:
Fair value of artifacts owned free and clear: $46 million (carried at cost of $3 million on Premier's books)
Fair value of artifacts that are currently under adjudication: > 100 million

The cash flows from operations for the business for the last 5 years (in millions, 2004-2008) : ($1.577), (.051), 2.13, 11.476, 17.142. Premier had 17.481 million in cash and marketable securities as of Feb 29,2008 and no debt, compared to cash and marketable securities of $547,000 as of Feb 28,2004.

How much is the entire company selling for today? How about $20.17 million? Intrigued? You ought to be. 

Disclosure: Long Premier at prices much higher than today's. Let's leave it at that while I go see my therapist about that purchase.

Often wrong but seldom in doubt,
Ragu

Friday, November 21, 2008

The fear behind Berkshire's free fall

I ought to have talked about it in the post about Berkshire's valuation. The reason is simple: Any time you believe there is a discrepancy between price and value for a particular security, it pays to understand why the discrepancy arose. Once you do, you can then make a reasonable assessment of whether the discrepancy is real or imagined. 

Over the last couple of days, there have been reports on Bloomberg and other sources that the cost of insuring Berkshire's debt has almost tripled over the last couple of months from 140 basis points to 415 basis points i.e. the cost of protecting a 100$ of debt owed by Berkshire went from $1.40 to $4.15. 

Median for Baa3 rated debt(lowest level of investment grade debt) was 348 basis points, compared to Berkshire's 415. If there's a more obvious illustration of irrational fear in the credit markets, I'd like to see it. Someone's going to make a ton of money shorting the Berkshire CDS' at these prices, perhaps more than someone thats just buying the equity. 

The fear(caused by the rising cost of Berkshire's debt protection) is that Berkshire will lose its AAA credit rating which would be an obvious blow to their insurance business, especially the super-cat business. Much as the rating agencies have behaved abominably during the real estate bubble, I'd seriously doubt a downgrade of Berkshire is in the works. Never say never I suppose, but lets see why fears of a credit downgrade are overblown.

The apparent(because I cant know for sure) reason for the surge in cost protection of Berkshire's debt is the equity index put options that have been written by Berkshire in the last few years. Lets forget the accounting for a minute and look at the economics of the transaction. 

1. Berkshire was paid $4.85 billion upfront in premiums for the put options.
2. The put options were written at market values for 4 stock indexes, 3 of them foreign over various times in the last 5 years.
3. Each of the contracts has a term ranging from 15-20 years.
 4. The options are European-style(which combined with the timeframe makes the transaction virtually risk-free for Berkshire), which means that they cannot be exercised except on the date of expiration.
5. The notional exposure on these contracts at the end of Q3 of 2008 was $37.042 billion.

So, what does Berkshire's bet mean? Simplifying for a minute (assume that the puts were written on one stock index and there's 13.5 years left on that contract, which is the average weighted remaining life on the contracts put together):

Market price of the index on the day the contracts were written: X
Market price of the index on the day the contracts expire(13.5 years from today): Y

If Y is less than X, Berkshire is liable to pay the difference to the put holder at the time of expiry of the contract, otherwise the puts expire worthless. Think about it: What are the odds that the indexes will be lower 15 years from now(approximately) than their peak, of say, last year? Free money for Berkshire, if you ask me. Add to it the fact that Berkshire gets to invest that $4.85 billion in a time of extreme financial turbulence. Brilliant timing. And the $37.042 billion in notional exposure? Thats the amount Berkshire is liable for, if all of the indexes on which these contracts are written against were trading at zero at the expiration date of these contracts. Lets just say we will have bigger problems than worrying about Berkshire's solvency if that eventuality came to pass.

Remember when I said to forget about the accounting for a minute? Well, that minute has passed and its time to understand why you see headlines in the financial media such as: "Berkshire Hathaway reports record 77 percent drop in quarterly profits".

As the market continues to decline:
1. The value of the puts(as estimated by Black-Scholes) decline. The current estimated fair value of the puts must be entered on Berkshire's books. This causes reported book value to decline.
2. The change in the value of the puts must also be applied to earnings. This means that, when the value of the puts decline, reported earnings take a hit, even though no cash payments have been made from Berkshire. This essentially renders reported GAAP earnings meaningless for analysis. The reverse is also true. When markets turn around, Berkshire will report "profits" from these contracts even though no cash payments will have accrued to Berkshire during that period. You can also expect the financial media to go ga-ga over these reported numbers and praise WEB's genius at that time. 

I hope this explains the fear behind Berkshire's drop and the irrationality of the fear. 

As WEB has said(paraphrasing): "To put up runs on the scoreboard, one must look at what's happening on the playing field, not whats happening on the scoreboard". 

On the scoreboard: Declining quoted prices for Berkshire's equity holdings, the "losing" put positions etc.

On the playing field(since the 3rd quarter only, Berkshire's been deploying plenty of cash since the end of last year): Berkshire buying 10% yielding preferreds in GE and GS(with an equity kicker to boot), MidAmerican buying CEG for a fraction of what it was worth at the start of this year, and the ability to buy billions of dollars of worth of securities at depressed prices with 2 of the greatest investing minds of all time allocating capital. 

I'd suggest what's happening on the playing field today will have a far greater impact on Berkshire's future net worth than what's being reported on the scoreboard. 

I'll say this again: At $77500 an A share and $2620 for the B's, Berkshire is stunningly cheap.

The obvious question from folks reading this then is: Why aren't you buying it? 
Two reasons:
1. I am fully invested at this point.
2. None of my other holdings are selling at prices close to where I would consider selling them. They aren't selling at prices close to where I bought them either, but thats another story for another day.

Often wrong but seldom in doubt,
Ragu

Thursday, November 20, 2008

Buyback to commence at Western Sizzlin

http://biz.yahoo.com/prnews/081119/ph47593.html?.v=1

At the end of the 3rd quarter of 2008, the company had $745,000 of cash and equivalents available. The operating cash flows from restaurant operations(without any adjustments) for the first 9 months of 2008 were at $1.15 million. It will be interesting to see how many shares(out of the authorized 500,000) they do end up buying back. They've also terminated the offer to Jack in the Box shareholders to tender their shares in exchange for shares in Western. I am happy with both of these developments.

Why is this interesting? Two reasons:
1. I am long WEST.
2. Sardar Biglari is the Chairman of Western. 

Who's Sardar Biglari, you ask?
Read this for an excellent primer on Western Sizzlin and how Sardar Biglari got to be its Chairman:
http://www.noisefreeinvesting.com/blog/?p=53

I believe the commencement of the buyback at WEST is a fairly telling indication of Sardar's estimate of its intrinsic value and the discount to that value that today's price represents. More thoughts on Western and its biggest investment(Steak 'N Shake) later.

Disclosure: Long WEST, at prices about 35% higher than today's (shares closed at $7.99 each, before the buyback announcement).

Often wrong but seldom in doubt,
Ragu

Wednesday, November 19, 2008

Thoughts on Berkshire's valuation

This is patterned on the two-column approach to Berkshire's valuation that Buffett encourages in his most recent shareholder letters.

Value of cash + investments at the end of Q3 (under "Insurance and other"): $133.525 billion

Annualized post-tax non-insurance operating earnings for 2009, net of minority interests: $4.24 billion

Market value of Berkshire today: $148.01 billion (B's selling for $3125 a share)

Unrealized investment losses in equities since the start of the year: $7.504 billion (and climbing since Q3)

If you believe the market value of Berkshire's equity holdings represented fair value at the end of Q3 (I dont, and you only need to look at the unrealized investment losses number to believe that this is a reasonable supposition) , then the implied multiple on the post-tax earnings of the non-insurance business is 3.4. 

Since the end of Q3, Berkshire has bought $8 billion worth of preferreds in GE and GS yielding 10%, along with an equity kicker. There's the MidAmerican deal to buy CEG. There is still about 9.8 billion worth of cash that can be deployed (leaving aside the $10 billion that WEB has said he'd set aside for insurance payments). And then, there's the bonds worth about $30 billion, a portion of which is likely to be committed to equities as the market continues to decline. And, last but not the least, the cash thats pouring into Omaha every week (about $8.428 billion for the first 9 months of 2008).

In my opinion, at these prices, Berkshire's current non-insurance businesses are being given away for free, businesses earning about $4.24 billion annually(in a recessionary environment), and Berkshire's current equity holdings are also more than likely undervalued. With Buffett and Munger at the helm, Berkshire is beautifully positioned to take advantage of a situation like today's, both on the investment side and the operational side. 

Berkshire has not been this cheap since Buffett's buyback offer in the middle of 2000. This doesnt mean the price wont get cheaper. It could, but that'd likely only make it an even better bargain than it is already. Berkshire's intrinsic value is growing rapidly at the same time that its price is declining. The spread between price and value will converge ultimately though and that ought to be the only thing that matters to folks buying at today's prices.

Disclosure: Long Berkshire, although I havent added to my position since the middle of 2006.

Often wrong but seldom in doubt,
Ragu

Tuesday, November 11, 2008

Getting started

Samir, Tejas and Paritosh: Thank you for pushing me to do this. In a bold move to embrace the 21st century, this is my first attempt at blogging, on a subject that I am passionate about (no, not cricket, for those of you that know me from a prior life). I expect to talk both about value investing in general, and also about positions that I own/am interested in. I expect this will be fun and a great learning experience. I hope you feel the same way too.

Often wrong but seldom in doubt,
Ragu[not claiming credit for the above]